Cross-Chain DeFi: Enabling Interoperability Between Blockchain Networks


Decentralized finance (DeFi) has exploded in popularity over the past few years, with the total value locked in DeFi protocols surpassing $100 billion in 2021. However, one major limitation of many DeFi applications is that they operate on a single blockchain network, unable to easily interact with protocols on other networks. Cross-chain interoperability aims to break down these silos by enabling communication between different blockchains.

In this post, we’ll explore the importance of cross-chain capabilities for the future growth of DeFi, examine some of the technical approaches to enabling interoperability, and discuss leading cross-chain DeFi projects bridging fragmented ecosystems.



The Need for Cross-Chain Interoperability in DeFi

Here are some of the key benefits cross-chain interoperability aims to unlock for DeFi:


  • Access to a wider range of financial services: Chains have different features and capabilities. Cross-chain interoperability allows the combining of services across platforms.
  • Liquidity fragmentation: Assets and liquidity get fragmented across chains. Cross-chain bridges let users easily transfer assets between chains and access larger liquidity pools.
  • Exchange rate efficiency: Cross-chain arbitrage helps equalize exchange rates and asset prices across chains.
  • Network effects: Cross-chain capabilities help blockchain networks interoperate instead of compete, accelerating adoption.
  • Specialization: Chains can specialize with cross-chain infrastructure allowing interoperability.

Without cross-chain interoperability, DeFi protocols remain isolated and unable to provide flexible and efficient financial services on a global scale. This is where Defi development companies can provide value by building cross-chain solutions.

Technical Approaches to Cross-Chain Interoperability


There are two main technical approaches to enabling cross-chain interoperability:

Layer 1 Bridges


Layer 1 bridges provide direct interconnectivity between two base-layer blockchain networks. Different techniques include:


  • Hash-locking: Assets are locked on one chain and unlocked by revealing the secret on the other.
  • Sidechains: Bidirectional transfers between a primary chain and a separate sidechain.
  • Relays: Block data is passed between chains via relayers.

Layer 1 bridges allow seamless transfers between chains but require direct technical integration between networks. Defi development companies can build customized layer 1 bridges for their clients.


Layer 2 Bridges


Layer 2 bridges are built on top of existing networks and provide indirect interoperability:


  • Custodial bridges: A custodian locks assets on one chain and mints a wrapped version on another. (e.g. WBTC)
  • Decentralized bridges: Smart contracts lock assets and issue tokens on each chain. (e.g. AnySwap)

While layer 2 bridges have some decentralization and counterparty risk tradeoffs, they don’t require changes to base layer protocols and can connect many chains. Defi development companies offer services to build decentralized layer 2 bridges.


Key Projects Bridging Blockchain Networks


Cross-chain bridges and protocols are now allowing assets, data, and applications to span different DeFi ecosystems. Here are some of the most prominent cross-chain DeFi projects:


  • Wrapped Bitcoin (WBTC): An ERC-20 token backed 1:1 with Bitcoin, allowing BTC liquidity on Ethereum DeFi.
  • Chainlink: Decentralized Oracle network providing external data to blockchains to enable cross-chain DeFi apps.
  • Polkadot: Heterogeneous multi-chain framework featuring a core relay chain and interconnected application-specific sidechains.
  • Cosmos: Network of independent parallel blockchains powered by Tendermint Byzantine Fault Tolerant (BFT) consensus.
  • THORChain: Decentralized liquidity network enabling trustless swaps between assets across chains like Bitcoin, Ethereum, and Binance Chain.
  • AnySwap: Multichain decentralized exchange and liquidity protocol interconnecting multiple chains like Ethereum, BSC, and Huobi ECO.

The Future of Cross-Chain DeFi


Cross-chain interoperability unlocks tremendous potential for the future growth of DeFi by removing fragmentation and technical barriers between blockchain networks.

Here are some exciting possibilities as cross-chain DeFi matures:

  • smoothly move assets between chains to access the best yields
  • build sophisticated cross-chain money Lego applications
  • enable decentralized trading across chains with efficient arbitrage
  • leverage unique features and strengths of different protocols across chains
  • allow sharding of DeFi into specialized chains that interoperate

While technical challenges around security, scalability, and decentralization remain, building bridges between blockchains is a crucial step toward a radically open global financial system. Defi development companies will continue innovating to make cross-chain DeFi a reality. Cross-chain DeFi promises to accelerate innovation and adoption by uniting disjointed ecosystems into a cohesive web of value exchange.


Conclusion

Interoperability in the fragmented blockchain landscape is key to unlocking the full potential of decentralized finance. Cross-chain infrastructure enables assets, data, and transactions to flow freely between protocols across technical boundaries. As both layer 1 and layer 2 solutions continue maturing, seamless DeFi composability between chains will become a reality, greatly expanding what’s possible. Defi Development Company plays an important role in driving cross-chain adoption. While progress may take time, cross-chain DeFi stands to revolutionize finance as we know it.

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